Junk Bond Protections Find Deeper Bottom

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Junk bonds issued in North America had record weak covenants in August. Bond protections for investors fell to a new record low, suggesting buyers are continuing to take on more risk in return for high yields, according to a Moody’s Investors Service report.

Moody’s Covenant Quality Index, which uses a three-month rolling average, weakened to 4.53 in August from 4.37 in July and 4.25 in June, surpassing the prior record of 4.42 set in November 2014. The rating service measures bond covenant quality on a five-point scale, with 1 indicating the strongest investor protections and 5 the weakest.

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“The record weakness of the CQI reflects investors’ continued acceptance of weak covenant protections,” Evan Friedman, Moody’s senior covenant officer, said in a news release. “They continue to trade away protections and take on more risk in search of higher yields.”

The percentage of low-rated bonds with weak covenants also hit a record high in August, increasing on a three-month, rolling-average basis to 78%, which easily eclipsed the previous record of 69% in July.

Corporate debt issuance froze for 13 consecutive days starting in August amid concerns about an economic slowdown in China. Among August’s issues, the most protective full high-yield package came from First Data, whose bond scored 3.57. The least protective package was issued by Kronos Acquisition Holdings, whose bond scored 4.63.

Three companies issued Caa-rated bonds that scored a 5 in all four of Moody’s risk categories: Summit Materials, Builder’s FirstSource, and Univar.